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Facebook Fiasco Has SEC Rethinking IPO Gag Rules

Law360, New York (August 27, 2012, 8:19 PM ET) -- After Facebook Inc.'s disaster of a first offering in May, U.S. securities regulators are considering whether to loosen limits on what companies can say in the days surrounding their initial public offerings, a move experts say could help level the playing field between small and large investors.

In a letter sent last week to Rep. Darrell Issa, R-Calif., U.S. Securities and Exchange Commission Chairman Mary Schapiro said she had instructed her staff to review the "quiet period" rules that generally bar company insiders and others from touting a public offering outside of a written prospectus reviewed by the agency.

"The IPO communications rules are designed to ensure that the prospectus remains the primary disclosure document," Schapiro wrote. "I also believe, however, that we should review our communications rules and the application of the quiet period in light of the changes in both the way the market functions and the changes in communications technology."

Federal securities laws limit the kinds of information an issuer and related parties can give the public in the time between publicly registering an IPO and when it is launched. Related rules restrict research analysts who are connected to an IPO from sharing their opinion with anyone besides clients.

The laws are designed to ensure that all of the information used to sell a public offering resides in a company's prospectus, which is reviewed by the SEC and available to any investor. But experts say the SEC needs to update its rules to allow for more flexibility and give companies the ability to promptly and directly communicate with all investors.

"This is just an old rule," said Tim Loughran, a professor of finance at the University of Notre Dame's Mendoza College of Business. "And I think it makes sense to review outdated IPO regulations like the quiet period."

Schapiro's comments were made in response to a June letter in which Issa partially blamed Facebook's botched IPO on antiquated and flawed securities laws. Issa questioned the logic behind rules that limit investors' access to information.

"The informational disadvantage to the less informed public proved harmful," Issa wrote of Facebook. "In contrast ... private investors received substantially greater detail regarding downgrades to expected earnings."

In Facebook's case, retail investors were unaware that the deal's underwriters, including Morgan Stanley and Goldman Sachs & Co., had downgraded their earnings forecasts for the popular social network, according to numerous shareholder suits. However, the banks told their clients — professional and institutional investors — about their gloomier expectations.

"There was a perception that large investors were treated differently than small investors, and that's something that the SEC can't stand," Loughran said. "Facebook's a disaster."

Besides a flood of shareholder lawsuits, the downgraded earnings forecasts and the manner in which they were disseminated prompted a review by state and federal securities regulators. They examined whether Facebook and its bankers selectively disclosed information in violation of Regulation FD, which bars issuers from sharing material nonpublic information with select parties.

Morgan Stanley allegedly subdued revenue estimates after Facebook disclosed that it was struggling to monetize its mobile offerings.

In a late amendment to its prospectus filed with the SEC, Facebook warned potential investors that it might not meet revenue expectations because more and more users were accessing the site through mobile devices. And mobile advertising is less profitable than advertising on the desktop site.

"The quiet period, in this particular case, acted in the opposite of the way it should have," New York securities attorney Wesley J. Paul said. "I would advocate for changing the quiet period rules to allow issuers to respond to misconceptions in the market."

The SEC most recently relaxed its quiet period rules in 2005, allowing companies to talk about their IPO in a number of settings, but only if their comments squared with their offering documents.

Despite the SEC's attempts at a softer stance, Facebook and its famous founder Mark Zuckerberg were no doubt wary of the quiet period and tailored their communications accordingly, attorneys said. They had a recent example of what not to do in Groupon Inc., which drew the attention of the SEC after an internal email touting the stock was leaked.

In an email to employees, Groupon CEO Andrew Mason touted the company's performance and blasted its critics who had called into question its business model that offers steep discounts at local businesses to its online subscribers, which now number over 100 million in 43 countries.

"While we've bitten our tongues and allowed insane accusations ... to go unchallenged publicly, it's important to me that you have the context necessary to brush this stuff off," Mason wrote

Before Groupon, it was Google Inc. that ran afoul of the quiet period, with its founders commenting on the company in an article in Playboy that appeared after the company had filed for its 2004 IPO.

Some companies now have new options when it comes to filing an IPO thanks to the recently adopted Jumpstart Our Business Startups Act. The JOBS Act mandated many changes to the country's IPO process, one of which allows companies to file a confidential draft registration statement with the SEC. The filing does not trigger the start of the quiet period, giving executives more time to speak freely about their companies.

Earlier this month, English soccer club Manchester United became one of the first companies to take advantage of the JOBS Act in going public. The club, among the most popular in the world, filed a confidential draft statement with the SEC, protecting its controversial owners from inadvertently running afoul of the agency's quiet rules, said Marc D. Jaffe of Latham & Watkins LLP, the lead attorney on the deal.

"I had no appreciation for how much media attention this club attracts," Jaffe said. "And that's a very difficult thing to deal with when you're going through the IPO process — there's so much you can't say."